Oil Rate Making

8/6/2019 Oil Rate Making

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Regulatory Basics for Oil Pipelines

September 16, 2009

AOPL Workshop


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Discussion Outline

Part I: Who regulates oil pipelines?

Part II: Procedures for filing tariffs.

Part III: The two major rate-setting methodologies.


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Part IFederal Energy Regulatory Commission

The federal authorityresponsible for

regulating oil pipelines


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FERC

Introduction

Also regulates the electric, hydro, gas industries.

Part of the Executive Branch.

An independent agency.

Extensive Congressional oversight. Funded by the fees charged to the entities it regulates

As of 2009, regulated 141 oil pipelines.

FERC departments important to oil pipeline industry:

Office of Energy Markets & Reliability

Office of Enforcement

Office of Administrative Litigation


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FERC

Organizational Chart


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FERCCommissioners as of Sept. 2009

Marc

Spitzer

R

Philip

Moeller

R

Jon

Wellinghoff

Chairman

D

Suedeen

Kelly

D


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FERC

Commissioners Appointed by the President with the consent of

the Senate.

Serve 5-Year Terms.

Equal vote on regulatory matters.

No more than 3 Commissioners of the samepolitical party.


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FERC

Office of Energy Markets & Reliability Principal advisor to the Commission on regulatory

issues.

Oversees energy market structure and performance.

Oversight of compliance of market participants with theCommission's rules.

Conducts analytical studies of energy markets.

OEMR Division Key to Oil Pipelines: Division of Tariffs and Market Development (Central Group)

1 of 6 divisions under OEMR


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FERC

Tariffs and Market Development (Central Group) Analyzes oil pipeline tariff and rate change filings.

Advises Commission on filings, initial decisions,rehearings, complaints, & declaratory orders.

Directs companies to perform oil pipeline statutorydepreciation studies.

Analyzes oil pipeline market-based rate applications.

Often assists pipelines in complying with regulations(e.g. ensuring tariffs meet all of the pertinentrequirements).


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FERC

Office of Enforcement Oversees compliance of market participants with the

Commissions rules for market activity.

Reports on the state of the energy markets, analyzingmarket activities and trends.

Advises the Commission on accounting and financialmatters affecting energy markets.

Oversees compliance with the Uniform System ofAccounts.

OE Divisions Key to Oil Pipelines:

Division of Financial Regulation

Division of Audits


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FERC

OE: Division of Financial Regulation Provides guidance to the Commission concerning its

financial accounting

Reviews new or proposed accounting standards

made by authoritative accounting bodies todetermine effect on regulated industries.

Prepares and coordinates necessary revisionsand/or amendments to the Commissions UniformSystem of Accounts.

Administers financial forms Nos. 1, 2, 2-A, 6, 3Q,6Q, etc.


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FERC

Form No. 6 What is the Form 6?

Required Annual Report of Oil Pipeline Companies who areregulated by the Federal Energy Regulatory Commission as set forthin the Interstate Commerce Act

Who uses the Form 6?FERC and Other Regulatory Commissions, Shippers, Carriers, AOPL,

Bureau of Economic Analysis

Purpose of the Form 6:To collect comprehensive financial and operational informationabout oil pipeline companies subject to the jurisdiction of the FERC General Corporate Information Financial Statements

Plant Statistical Data Allowed Cost-of-Service (Page 700)

Filing Dates Year-End (Form 6)- April 18th

Quarterly (Form 6-Q) (70 days after the quarter ends)


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FERC

OE: Division of Audits Performs financial and operational audits of industryparticipants.

Performs audits on a random basis. Authority to audit all FERC regulation related records

Represents the Commission and explains and advocatesits legal and policy positions. Advises the Commission on compliance related matters.


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FERC

Offices Involved in Rate Cases Office of Administrative Litigation (OAL)

Resolves disputes through settlement. Litigates unresolved issues at hearing. Commission Staff and lawyers represent the public interest.

Office of Administrative Law Judges (OALJ) Resolves contested cases as directed by the Commission,

either through impartial hearing and decision or throughnegotiated settlement.

Conducts fair and impartial investigations as directed bythe Commission.

Performs various alternative dispute resolution (ADR) asdirected by the Commission.


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Part II

Rate-Setting Procedures

Initial RatesIndexed Rates

Grandfathered RatesSettlement Rates

Market-Based RatesCost-of-Service Rates


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Rate-Setting Procedures

Introduction Where are regulations pertaining to oil pipelines located?

Code of Federal Regulations, Title 18 - Conservation of Power andWater Recourses (CFR 18)

FERC & DOE regulations: Volume I, parts 1 to 399. Chapters pertinent to oil pipelines:

Subchapter P Regulations under the Interstate Commerce Act(ICA), Parts 340-350

Subchapter Q Accounts under the ICA, Parts 351-352 Subchapter R Approved Forms, ICA, Parts 356-357

Where are regulations specific to tariff filings located? 18 C.F.R. 340 Tariffs must be filed 30 days prior to taking effect, 18 C.F.R. 341.2

Neither the filing date nor the effective date are counted in the 30days

Short notice exception Tariff must be formatted in conformance with regulations, 18 C.F.R.

341.3


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Tariff Rate Types

Initial Rates (18 C.F.R. 342.2) A carrier must justify an initial rate for a new service by:

a) Filing a cost-of-service to support such rate, or

b) Filing a sworn affidavit that the rate is agreed to by

at least one non-affiliated shipper who intends to

use the service in question (a negotiated rate).


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Tariff Rate Types

Indexed Rates 18 C.F.R. 342.3 A rate may be changed, at any time, to a level not to

exceed the ceiling level.

The current period ceiling level equals the product of theprevious index years ceiling level and the most recent

index published by the Commission.

Index published prior to June 1 of each year.


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Tariff Rate Types

Grandfathered Rates Section 1803(a) of the Energy Policy Act of 1992

(EPAct) deems just and reasonable any rate in effectfor the 365-day period ending on the date of theenactment of this Act if the rate in effect has notbeen subject to protest, investigation or complaint duringsuch period.

A grandfathered rate can be challenged if:

a substantial change has occurred after October 24,1992, in the economic circumstances of the oil

pipeline which were a basis for the rate, or a substantial change has occurred after October 24,

1992, in the nature of the services provided whichwere the basis of the rate.


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Tariff Rate Types

Settlement Rates 18 C.F.R. 342.4 A carrier may change a rate without regard to the ceiling

level if the proposed change has been agreed to, in

writing, by each person who, on the day of the filing of

the proposed rate change, is using the service coveredby the rate.


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Tariff Rate Types

Market-Based Rates 18 C.F.R. 342.3

Carrier must demonstrate that it lacks significant market

power in the in the origin market and the destination

market.

Filing requirements established in 18 C.F.R. 348. These filing requirements require a relatively lengthy

application.

If the application is approved, the carrier may set rates

at whatever level the market will bear.

Chris Lyons and I will be giving a presentation discussing

market-based rates in significant depth at XX


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Tariff Rate Types

Cost-of-Service Rates 18 C.F.R. 342.4 Carrier must show that there is a substantial divergence

between the actual costs experienced by the carrier and

the rate resulting from the application of the index such

that the rate at the ceiling level would preclude the

carrier from being able to charge a just and reasonablerate within the meaning in the Interstate Commerce Act.

Filing requirements established in 18 C.F.R. 346

More on cost-based rates to come


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PART III

Cost-of-Service Rates


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Cost-of-Service

Introduction Types of Cost-of-Service Methodologies:

Depreciated Original Cost (DOC)

Trended Original Cost (TOC)

COS Methodology Prescribed by the Commission: The

Opinion No. 154-B Cost-of-Service Methodology

Issued June, 1985

Utilizes a TOC rate base

Has been modified and clarified by subsequent

decisions.


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Cost-of-Service

Depreciated Original CostOperating Expenses

+ Return of Rate Base (Depreciation)

+ Return on Rate Base+ Amortization of Allowance for Funds Used

During Construction (AFUDC)

+ Income Tax Allowance= Cost of Service (Revenue Requirement)


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Cost-of-Service

Operating Expenses Salaries and Wages

Materials and Supplies

Outside Services

Fuel and Power Pensions and Benefits

Insurance

Oil Losses and Shortages

Taxes other than Income Taxes Allocated Overhead


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Allocated Overhead

For pipelines that are subsidiaries of a largercorporation, allocated overhead can represent a

significant component of the COS.

The Commission generally uses a three factor

approach consisting of revenue, plant and payroll to

allocate overhead.

Other approaches are permissible.

The critical issue is that the allocation methodologymatch cost with causation.


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Cost-of-Service

Depreciation Depreciation Example:

Beginning of Year 1 Rate Base = 1000

Estimated Life = 20 years

Year 1 Depreciation Expense = (1000 / 20) = 50

Group Method of Depreciation: a number of similar orrelated assets are included in a group to which a singlecomposite depreciation rate is applied.


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Cost-of-Service

Rate BaseCarrier Property in Service

- Accumulated Depreciation

+ Allowance for Funds Used During Construction

(AFUDC)- Accumulated Amortization of AFUDC

+ Working Capital Allowance

- Accumulated Deferred Income Taxes (ADIT)

= DOC Rate Base


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Cost-of-Service

Accumulated Deferred Income TaxCalculation of ADIT Year 1 Year 2 Year 3 Year 4

Tax Depreciation 33.3 33.3 33.3 -

Book Depreciation 25.0 25.0 25.0 25.0

Timing Difference 8.3 8.3 8.3 (25.0)

Deferred Income Taxes 4.2 4.2 4.2 (12.5)ADIT 4.2 8.3 12.5 -

Property 100

Book Depreciation 25%

Tax Depreciation 33%Income Tax Rate 50%

Equity % 100%

ROE 10%

Assumptions


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Cost-of-Service

Return on Rate BaseDebt % x Cost of Debt

+ Equity % x Nominal Equity Rate of Return

= Weighted Cost of CapitalAverage DOC Rate Base

x Weighted Cost of Capital

= Return on DOC Rate Base


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Cost-of-Service

Allowance for Funds Used During ConstructionAverage Monthly Construction Work in Progress (CWIP)

Balance

x Weighted Cost of Capital

= AFUDCAverage AFUDC Balance

x Useful Life Factor

= Amortization of AFUDC


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Cost-of-Service

Income Tax AllowanceEquity Portion of Return on DOC Rate Base

+ Amortization of Equity AFUDC

= Taxable Elements of Return

x Net-to-Tax Multiplier

= Income Tax Allowance

Income Tax Rate*

(1.0 Income Tax Rate)

= Net-to-Tax Multiplier*Generally based on the statutory marginal tax rate for corporations


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Cost-of-Service

DOC Recap

Operating Expenses

+ Return of Rate Base (Depreciation)

+ Return on Rate Base+ Amortization of Allowance for Funds Used

During Construction (AFUDC)

+ Income Tax Allowance= Cost of Service (Revenue Requirement)


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Cost-of-Service

Trended Original Cost (TOC) Variation of DOC.

Stores inflation adjustment in Rate Base and recovers asDeferred Return over life of assets.

Applies Real Return on Equity (ROE)1/ to equityportion of Rate Base and Cost of Debt (COD) to debtportion of Rate Base.

Trends portion of Rate Base funded by equity to reflectinflation as measured by the CPI-U.


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Cost-of-Service

Nominal Equity Rate of Return

Real

Rate

ofReturn

InflationTOC

Rate Base

TOC

Cost of

Service

DOC

Cost of

Service


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Cost-of-Service

Calculation & Amortization of Deferred ReturnTrending Base (Equity Rate Base)

x Inflation Factor

= Deferred ReturnDeferred Return

x Useful Life Amortization Factor

= Amortization of Deferred Return


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Cost-of-Service

Opinion No. 154-B Issued June of 1985.

Adopts the trended original cost rate base (TOC)for oil pipelines wishing to establish or change their

tariff rates by filing a cost-of-service.

Provides for a transition from the previous valuationrate base methodology, referred to as the startingrate base, (SRB).

Advocates use of the pipelines actual capital

structure. Case-by-case determination of many issues.

* FERC Opinion No. 154-B, as modified and clarified by subsequent decisions


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Cost-of-Service

Starting Rate Base Intended to provide transition from prior methodology.

One-time calculation as of December 31, 1983.

SRB Formula:

(Debt % x Net Original Cost)+ (Equity % x Net Reproduction Cost New)

= Starting Rate BaseStarting Rate Base (SRB)

- DOC Rate Base

= SRB Write-Up


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Cost-of-Service

Starting Rate Base Write-Up SRB Write-Up is included in Opinion No. 154-B

Rate Base.

SRB Write-Up is amortized.

Amortization of SRB Write-Up is excluded fromCost of Service.

Carriers Return On Rate Base includes a return

on the unamortized SRB.

SRB Write-Up is included in Trending Base when

computing Deferred Return.


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Cost-of-Service

Rate Base ComponentsDOC Rate Base

+ SRB Write-Up

- Accumulated Amortization of SRB Write-up+ Deferred Return

- Accumulated Amortization of Deferred Return

= 154-B TOC Rate Base


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Cost-of-Service

Income Tax AllowanceEquity Portion of Return on TOC Rate Base

+ Amortization of Deferred Return

= Subtotalx Net-to-Tax Multiplier

= Income Tax Allowance


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Cost-of-Service

Base & Test Periods A base period must consist of 12 consecutive months of

actual experience adjusted to eliminate non-recurringitems. Carrier may include appropriate normalizingadjustments in lieu of non-recurring items.

A test period must consist of a base period adjusted for

changes in revenues and costs which are known andmeasurable with reasonable accuracy at the time offiling and which become effective within nine monthsafter the last month of available actual experienceutilized in the filing. For good cause shown, theCommission may allow reasonable deviation from theprescribed test period.

See 18 C.F.R. 346.2.


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Critical Take-Aways on COS

The calculations contain a number of variables thatfunction in tandem.

Some of the required inputs involve data going back

over 25 years.

The higher the quality of the data the more

successful a cost-based rate filing will be.


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Questions?

Oil Rate Making

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